Director Fees Update: Substantial Nexus and the Property Factor

By Garry Fujita

On August 27, 2010, we addressed the taxation of director fees in the article, Washington State B&O Tax on Director Fees.  In that post, we addressed the substantial nexus requirement that is necessary before Washington may extend its B&O tax to director fees.

We refer you to that August 2010 article for a more detailed discussion, but by way of a quick review, a director has substantial nexus if:

  1. the director is a Washington resident or is domiciled in Washington; or
  2. the director is a nonresident who has:
    1. more than $50,000 of property in the state;
    2. more than $50,000 of payroll in the state;
    3. more than $250,000 of receipts from the state; or
    4. at least 25% of his or her total property, total payroll, or total receipts in this state.

At that time, we raised a question regarding the property factor for a nonresident.  The question was whether “property” meant only business property or both business and nonbusiness property (e.g., vacation property).  Without guidance from the Washington Department of Revenue, we suggested that the safest course of action was to assume that the state would decide that both types of property should be considered.  In a recent query to the Taxpayer Services for the Washington Department of Revenue, we were told that, in fact, the agency has made the policy decision to include all property, although the question was admittedly a “close call.”

We have not seen any agency declaration of that position or seen any analysis supporting it, but there certainly is rational support for that position.  First, there is no limiting language in the statute.  On its face, “property” can include both business and nonbusiness property.  Second, to the extent that a court would likely assume that the legislature knew the difference between business and nonbusiness property, one could point to RCW 82.0.067(2)(e) to demonstrate that the legislature knows how to limit “property.”  In that section, the legislature specifically excluded “a person’s ownership of, or rights in, computer software as defined in RCW 82.04.215, including computer software used in providing a digital automated service; master copies of software; and digital goods and digital codes residing on servers located in this state.”  Thus, if the legislature found it appropriate to exclude software, digital goods and digital codes, then why did it not exclude nonbusiness property as well?

However, we do not believe that the analysis should end with a review of the statute alone.  As nexus is a constitutional concept for commerce clause purposes, we think that the commerce clause should be consulted too.  Under commerce clause analysis, nexus can be dissociated from the activity that the state seeks to tax if the nexus is unrelated to that activity.  According to the Department of Revenue:

Once nexus is established, the general rule is that all sales transactions are subject to B&O tax liability.  Put another way, nexus for one sale is nexus for all sales.  An exception to this general rule applies only to those particular sales where the seller can establish that the sale was not associated in any way with the in-state activity which created the nexus.  This burden of proof was addressed by the United States Supreme Court in Norton Co. v. Illinois, 340 US 534, at 537-538 (1951), where the court stated:

But when, as here, the corporation has gone into the state to do local business by state permission and has submitted itself to the taxing power of the state, it can avoid taxation on some Illinois sales only by showing that particular transactions are dissociated from the local business and interstate in nature.  The general rule, applicable here, is that a taxpayer claiming immunity from a tax has the burden of establishing his exemption.  This burden is never met by showing a fair difference of opinion which as an original matter might be decided differently. . . . (Emphasis added.)

Det. No. 87-69, 2 WTD 347, 350 (1987) (italics supplied, underline in original text).

In the context of director fees, a nonresident director with nonbusiness property in Washington could contend that the nexus created by the nonbusiness property is dissociated with the director fees earned.  The argument would be that the director fees “are not associated in any way with” the family beach property in the San Juan Islands or a condo at Crystal Mountain (assuming that no business entertainment occurs at the property).  For purposes of taxing the director fees, only the property related to generating the director fees should create the required nexus.  The nexus created by the nonbusiness property should be irrelevant.  However, until judicial scrutiny is given to this issue, the safest course of action for a nonresident director is to assume that Washington Department of Revenue will include the director’s  nonbusiness property located in Washington for the purpose of  establishing the required nexus.

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